real estate dispositions is the focus of this guide for passive real estate investors. First, it highlights the main idea behind the topic. It also outlines the risks and questions worth reviewing. As a result, you can approach the discussion with a clearer framework.
What to know about real estate dispositions
By the end of 2021, our team will have gone full cycle and sold 6 different assets. All these assets will have outperformed the original projections from when we acquired the assets. All of them are also being sold earlier than the original projected hold period.
This is always great to hear when we outperform projections but some of you may be thinking, “why sell early?” or “why not refinance” or “why not hold longer.”
On-going BOV’s
Each asset that we acquire is evaluated at least once a year and sometimes twice a year to determine the current value of the asset. This is called a BOV or broker’s opinion of value.
Our asset management team works on these to allow us to make decisions on when it is ready for us to capitalize on the gains of our investments.
Once we have these BOVs, we can decide on whether we can sell, refinance, or continue to hold the asset.
Why Sell Early?
Selling early is a decision that is made when we feel like selling at a peak is going to yield a greater return than originally projected.
What this means for investors
When making the “sell early” decision, we also determine the ability to increase returns by allowing investors to 1031 exchange into another asset. More on this a little later.
Refinancing as an Option
In some cases, it can make more sense to refinance an asset to be able to return come capital back to investors. This is usually done after an asset has completed a renovation plan which has allowed for a substantial increase in the NOI (net operating income).
This is usually an option when 30-40% of the capital can be returned back to investors and the market has not made any significant compressions to the cap rates in a market.
It would not make sense to sell in that situation until after the projected hold period. Plus, the refinanced loan could allow for higher cash flows if the debt service is more favorable.
Holding Forever
Many are of the mindset that holding an asset forever along with several refinances over the years is the way to go. However, this is not usually going to yield you the highest return.
Questions to ask before acting
Even if you have an asset that you can refinance 100% of your initial capital back, you are not technically making an infinite return. You still have real equity built up within the asset and you must think about it a little differently.
If you sell the asset, you can then redeploy that capital into a potentially higher cash flowing asset and ride that asset up for the next cycle. Yes, it will take a little work, especially on our part for your passive investments, but it will yield a higher return than having dead equity in an asset not working for you.
Greater Returns with 1031 Exchange
I want to give you an example of an asset we are selling right now. I can’t name the asset as it is going through due diligence right now, but many of you will know the asset as you are invested in this one.
We bought this asset 2 years ago for approximately $52mil and we receive a BOV from the broker earlier this year that they could sell it for $72-73mil. After reviewing the financials further, we decided that it would make sense for us to sell the asset since our 5-year projections were to sell the asset for $70mil and of course here we are 3 years early already achieving the projected returns.
Risks and tradeoffs to review
After going through the full marketing process and interviewing several potential buyers, this asset is actually under contract to sell for much higher than the BOV. As a matter of fact, this asset is selling closer to $80mil. You heard that right. It is selling for $10mil more than the 5-year projection.
We could have refinanced this one, but the bank would not have given us that high of a valuation as these buyers. So, the refinance proceeds would have been much lower.
With this asset being sold, it will allow us to perform a 1031 exchange with our passive investors into another solid, cash flowing asset to allow them to defer their capital gains and depreciation recapture.
And of course, increase their overall return.
So how does this work for you as a passive investor when we perform a 1031 exchange.
First off, we don’t force you to do the 1031 exchange with us. You can choose to either liquidate your investment or you can go along with us into another asset via the 1031 exchange. If you liquidate you will pay the taxes on the gain and if you 1031, this allows you to defer the gain.
Practical next steps
The nice thing about doing these 1031 exchanges is that it will allow you to increase your unreturned capital contribution over time which allows you to have a high cash flow during the hold period.
For example, if you had originally invested $100,000 into this investment, your proceeds at sale would be a 1.70x. This equates to $170,000 at closing. When we complete the 1031 exchange into the next asset, your new initial investment will be $170,000 instead of the original $100,000.
Since the preferred return is calculated based on this unreturned capital, your cash flow increases since it is based off the $170,000 and not the $100,000. For a preferred return of 7% the preferred return each year would go from $7,000 with the $100,000 original investment to $11,900 based on the 1031 proceeds of $170,000.
Making the Decision
As you can see, there are many different items that we must consider when deciding whether to sell, refinance, or hold. These are constant decisions that we are always considering maximizing the return for your investment.
The nice thing about it is that you don’t have to worry about it. We do our best to stay on top of all these decisions, so you enjoy life and not have the headache of managing your investment.
What this means for investors
It is nice to see these assets selling and going full-cycle this year and we see more assets being sold next year while we are seeing a strong market for sellers even into 2022.
Key takeaways for real estate dispositions
- Start with the goal and timeline that fit your wider financial plan.
- Next, review the assumptions, risks, fees, and possible outcomes.
- Finally, compare the opportunity with other ways to use your capital.
Put real estate dispositions in context
Core ideas for real estate dispositions
Every investment decision depends on the investor, the deal, and the market. Therefore, use the ideas above as a starting point for deeper due diligence. Review source documents, ask direct questions, and seek qualified advice when needed. For more guidance, explore our passive real estate investing education.
A clear review of real estate dispositions
real estate dispositions deserves a clear and practical review. These short checks can support a more informed decision.
- Start with a clear goal.
- Next, define the time horizon.
- Review each key assumption.
- Compare the likely outcomes.
- Test a less favorable case.
- Ask who controls each decision.
- Confirm the fees and incentives.
- Study the market and the deal.
- Check the supporting documents.
- Look for clear communication.
- Compare other choices.
- Keep the full plan in view.
- Write down the main risks.
- Review the source of returns.
- Check the exit assumptions.
- Understand the tax questions.
- Consider the need for liquidity.
- Match the choice to your goals.
- Ask direct follow-up questions.
- Confirm the reporting process.
- Review the operating plan.
- Check the team’s experience.
- Compare the best and worst cases.
- Keep expectations realistic.
- Use qualified advice when needed.
- Document the final decision.
- Review the decision over time.
- Watch for changing conditions.
- Stay focused on the long term.
- Finally, act with a clear reason.
A practical review of Dispositions: How We Determine When It’s Right To Sell
First, define the goal for this decision. Next, write down the result you expect. Then, identify the facts that support that result. Finally, note any facts that could change your view.
For example, compare the likely return with the main risks. In addition, check the timeline and the amount of control you will have. However, do not rely on one attractive number. Instead, review the assumptions behind every estimate.
Before you act, ask who will manage the work. Also, confirm how that team will report progress. If conditions change, decide how the plan can adapt. As a result, you can judge the opportunity with more confidence.
Moreover, compare this choice with realistic alternatives. For instance, consider liquidity, taxes, fees, and timing. Likewise, review the downside as closely as the upside. Therefore, your final decision can reflect both your goals and your limits.
In short, use a clear process. First, gather the facts. Next, test the plan. Then, ask direct questions. Finally, choose only when the answers support your strategy.